SEC Chair White Discusses Intermediation in Securities Market; Focuses on Debt Markets, Particularly Munis

SEC Chair Mary Jo White delivered a speech at the Economic Club of New York, discussing the changing nature of intermediation and the importance of considering competition and technology in addressing market structure issues.

Chair White explained that securities markets operate within a structure of rules which is based not only on regulation, but also on the complex interaction of regulation with competition and technology. Considering this “dynamic reality,” Chair White stated that the SEC should not be chasing regulatory solutions that “fix” market structure once and for all, since the “markets are not broken and they are not static.”

Chair White emphasized the importance of understanding the broader forces at work in market structure and the regulatory choices available. She used Regulation NMS (“Reg. NMS”) as an example of the need for a wider lens in evaluating market structure issues, explaining that while Reg. NMS and high-frequency trading (“HFT”) share temporal similarities, there are more complex forces at play. According to Chair White, this is supported by the fact that there are markets around the world with high levels of HFT even though they are not governed by Regulation NMS.

She went on to discuss how intermediation has changed in equities and listed options. Chair White explained that when Congress first mandated the regulation of trading in U.S. securities, intermediation was defined by the respective functions of exchanges, brokers, and dealers; however, these functions now overlap and have been combined. According to Chair White, conflicts of interest have arisen due to dual roles that such entities play. Additionally, she stated that concerns have been raised about excessive intermediation by dealers, the costs of which are difficult to measure since they are embedded in trading profits.

Due to these developments, Chair White stated that it is essential to continually rethink how to approach intermediation in both equity and fixed income markets. In equity markets, where Reg. NMS was implemented in 2007, Chair White further stated that the current structure was created mostly through intense competition and tremendous technological changes. Chair White explained that the impact of technology and competition on intermediation in equity markets “cannot be undone through minor regulatory surgery,” as it is the culmination of over a quarter of a century of technological evolution, much of which “has benefited investors.” She stated that the SEC must be sure that any future rules are able to keep pace with developments.

In fixed income markets, where “there is no equivalent of Regulation NMS and the nature of intermediation has changed relatively little over the years,” Chair White stated that she wants technology to be leveraged to make the old, decentralized method of trading more efficient for market intermediaries to potentially benefit investors. To this end, Chair White has asked FINRA and the MSRB to prioritize two initiatives: (i) a robust best execution rule for the municipal securities market, and (ii) developing rules regarding disclosure of markups in “riskless principal” transactions for both corporate and municipal bonds. More broadly, Chair White emphasized that the SEC must take steps to ensure that the benefits of technological advances are realized by all investors in fixed income markets, explaining that she has asked SEC staff to focus on an initiative to enhance public availability of pre-trade pricing information with respect to smaller retail-size orders.

Lofchie Comment: Chair White continues a reasonable and measured approach as she orders an agency review of the markets after the publicity frenzy over Flash Boys: A Wall Street Revolt. With regard to the direction of the SEC’s review of the equity markets, it will be interesting to see the biases between exchange trading and other forms of intermediation. As to trading in the fixed income markets, it seems likely that very significant additional regulation is on the horizon. Financial regulatory history shows: (i) that regulation always grows and (ii) that any regulation that comes to the equity markets comes eventually to the fixed income markets. Hopefully, when new regulation comes, it will arrive with appropriate modification to reflect the differences between the two markets.

See: Chair White’s Speech.